The definition of a retirement gap is when the income you are on track to have when you retire—from sources like Social Security, pensions, part-time work, or a 401(k)—falls short of the income you will actually need to retire the way you want. While you may be working with a well-planned budget in your golden years, rising costs and unexpected expenses could cause a discrepancy between your retirement income and your actual needs. Thus, when drawing up your retirement plan, you need to be prepared for the possibility of income gaps.
Longevity and Lifespan
The good news: overall we’re living longer and healthier lives. The bad news: as lifespans increase and the economy experiences unforeseen shifts, the amount of money needed in retirement may be more than you planned for. This isn’t bad news, exactly, but it does create the need for more foresight and flexibility when it comes to long-game financial planning. A greater duration of longevity likely means a longer retirement, and that creates the potential for a greater money deficit.
Total Income Gap
Your total income gap is the difference between your retirement income target—which encompasses necessary living costs as well as extras, like travel expenses and other bucket list items—and the total guaranteed lifetime earnings you’ve acquired over the course of your employment, such as Social Security, pension benefits, and any deferred compensation. For example, someone who wants $160,000 per year in retirement to maintain their lifestyle but receives $60,000 per year from guaranteed lifetime earnings, would have a $100,000 total income gap.
How to Determine Your Retirement Gap
You could use a retirement income calculator, but online tools cannot take into account your personal lifestyle plans. A better option might be to add up all your potential retirement income sources, like 401(k), Social Security, Individual Retirement Account (IRA), pension, and other savings investments. Next, calculate a plausible estimate of the funds you will need for your retirement. This can be calculated as either a monthly or lump sum. Finally, subtract your essential funds from the amount you are estimated to have. Any discrepancy is your retirement gap. If you find this process overwhelming, meeting with a financial advisor could provide you with a clearer picture of your retirement finances.
How to Bridge the Retirement Gap
Once you have a better picture of your retirement savings, there are steps you can take now to bridge the gap, grow your savings, and secure financial sustainability throughout retirement. Perhaps the most obvious way is to start ramping up your saving effort. Start here:
- Examine and rework your budget.
- Tighten spending on extras like restaurant and take-out meals, vacations, and any superfluous extras.
- Transfer high-interest credit card balances to a card with a more competitive rate to pay down balances faster.
- If it’s feasible (say, with the money you are saving by cutting back on extra spending), think about maxing out catch-up contributions to your 401(k), supplemental retirement plan, or IRA.
If you are counting on Social Security benefits as a significant portion of retirement income, you may want to wait to retire until your full retirement age as benefits increase each year you delay retirement.
Another option for bridging the gap is to adjust your outlook of retirement and adopt a semi-retirement strategy where you continue to work part-time or on a project basis. You might find that your career easily segues into freelance, consulting, or independent contract work, so you can continue to earn income while spending more time with family and pursuing hobbies. Or perhaps a hobby has the potential to grow into a side or part-time gig.
Finally, reevaluate your investment game plan. In lieu of shifting all your funds to more conservative investment options as you age, work with a financial professional to assist in procuring a combination of investments that have the potential to grow your retirement funds in a shorter period.
Implementing several small steps such as the ones above will help you cover a retirement savings shortfall.
